July COVID-19 financial reporting, governance, and risk management

| 7/22/2020
July COVID-19 financial reporting, governance, and risk management

Special message from Mike Percy, Managing Partner, Financial Services

Dear FIEB readers,

I continue to hope this message finds you, your friends, your family, and your colleagues safe. With the second quarter in the rearview mirror, the financial reporting results are unfolding. Initial filings mostly are reporting bleaker earnings, or losses, as compared to the first quarter. We continue to face uncertainty with COVID-19 on many fronts, including whether the recovery will be in the shape, or perhaps shapes, of a V, U, W, or L. Given our resiliency, we will all find our way to a new normal.

As we operate in this continuing unusual environment, we once again have organized this month’s Financial Institutions Executive Briefing to focus on the most critical issues and will strive to keep you updated as events unfold.

Matters of importance from the financial regulators

FDIC issues “Quarterly Banking Profile” for first quarter 2020

The Federal Deposit Insurance Corp. (FDIC) issued, on June 16, 2020, its “Quarterly Banking Profile,” covering the first quarter of 2020. According to the report, FDIC-insured banks and savings associations reported $18.5 billion in net income, down $42.2 billion (69.6%) from a year ago. The decrease in net income was attributable primarily to an increase in provision expenses and goodwill impairment as a result of overall deteriorating economic activity.

The report provides these additional statistics:

  • The average net interest margin decreased by 29 basis points from a year ago to 3.13%.
  • Community banks earned $4.8 billion during the first quarter, down 20.9% from the same period last year.
  • Total loans and leases increased by $442.9 billion (4.2%) from the previous quarter.
  • Net charge-offs increased by $1.9 billion (14.9%) from a year ago, and the average net charge-off rate increased slightly from 0.50% to 0.55%.
  • From the previous quarter, noncurrent loans (those 90 days or more past due) increased slightly, by 2 basis points to 0.93%.

The total number of FDIC-insured commercial banks and savings associations declined to 5,116 from 5,177 the previous quarter. The number of institutions on the problem bank list was 54, two new banks were chartered, and one bank failed.

NCUA issues first-quarter 2020 performance data

On July 1, 2020, the National Credit Union Administration (NCUA) reported quarterly figures for federally insured credit unions based on call report data submitted to and compiled by the agency for the first quarter of 2020. Highlights include:

  • The number of federally insured credit unions declined from 5,335 in the first quarter of 2019 to 5,195 in the same quarter of 2020 (3,255 federal credit unions and 1,940 federally insured, state-chartered credit unions).
  • Total assets in federally insured credit unions rose by $132 billion (8.8%) over the year to $1.64 trillion.
  • Net income at an annual rate was $8.4 billion, down $5.6 billion, or 40%, from the previous year. The decline is due primarily to an increase in loan and lease loss provisions and credit loss expenses.
  • The return on average assets decreased from 95 to 53 basis points compared to a year ago.
  • The credit union system’s net worth ratio decreased slightly from 11.13% last year to 11.01%.

OCC’s “Semiannual Risk Perspective” focuses on financial impact from COVID-19

On June 29, 2020, the Office of the Comptroller of the Currency (OCC) released its “Semiannual Risk Perspective” for spring 2020. At the start of the coronavirus pandemic banks were in a strong position, but the quick decline in economic conditions has significantly affected bank earnings, credit quality, operations, and capital. In the report, the OCC recognizes that the federal banking system is experiencing weak financial performance and elevated credit risks, operational risks, and compliance risks.

The report notes increasing credit risk in most industries as a result of volatility in the credit environment from the impact of COVID-19. The OCC identifies some drivers for the increased credit risk including high unemployment levels, risks of default, bankruptcy, dissolution, and new loan relief programs. The OCC further says that flexible and proactive credit risk management practices will be necessary in this environment. Additionally, elevated operational risk continues as banks institute new processes and procedures, address pandemic plans, and respond to rising fraud and cyberrisks.

In addition, the report highlights continued heightened compliance risk resulting from changes in operations as a result of the pandemic and new federal and state programs including the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the Paycheck Protection Program (PPP), among others. The changes in operations and high volume of PPP applications may result in challenges for complete and accurate operation of bank policies to fulfill Bank Secrecy Act, consumer protection, and fair lending requirements.

FDIC issues final rule regarding deposit insurance assessment

On June 22, 2020, the FDIC issued a final rule to mitigate the deposit insurance assessment impact of participating in the PPP, the Paycheck Protection Program Liquidity Facility (PPPLF), and the Money Market Mutual Fund Liquidity Facility (MMLF).

The final rule removes the effect of PPP lending in calculating the deposit insurance assessment and provides an offset to the total assessment amount for any increase attributable to participation in the PPP and MMLF.

Agencies finalize changes to Volcker rule, modifying “covered funds” restrictions

The FDIC, Federal Reserve Board (Fed), OCC, Securities and Exchange Commission (SEC), and Commodity Futures Trading Commission, on June 25, 2020, finalized proposed changes to the Volcker rule. The changes, which will be effective Oct. 1, 2020, primarily modify restrictions around “covered funds” – hedge funds and private equity funds – to clarify areas of compliance uncertainty that the rule did not intend to restrict. The changes are aimed at facilitating capital formation, protecting safety and soundness and financial stability, and providing greater clarity and certainty about what activities are permitted. The rule also addresses the extraterritorial treatment of certain foreign funds.

Agencies issue statement on managing risks associated with LIBOR transition

On July 1, 2020, the Federal Financial Institutions Examination Council (FFIEC) issued a statement highlighting risks associated with the expected discontinuation of the London Interbank Offered Rate (LIBOR). The risks identified in the statement include:

  • Operational difficulty in quantifying exposure
  • Financial, valuation, and model risk related to reference rate transition
  • Inadequate risk management processes and controls to support transition
  • Consumer protection-related risks
  • Limited ability of third-party service providers to support operational changes
  • Potential litigation and reputational risk arising from reference rate transition

The statement also identifies key steps toward managing these risks, including assessing LIBOR exposure, addressing fallback language in contracts (language about how a discontinued rate will be handled), identifying consumer impact when retail loans include LIBOR references, and evaluating third-party servicer considerations.

In addition, the statement outlines the supervisory focus related to LIBOR for 2020 and 2021.

FinCEN issues guidance on due diligence for hemp businesses

On June 29, 2020, the Financial Crimes Enforcement Network (FinCEN) issued guidance to assist financial institutions in conducting due diligence for hemp-related businesses. The guidance is meant to supplement guidance issued in December 2019.

Due diligence expectations outlined in the guidance include confirming the hemp grower’s compliance with various licensing requirements by obtaining either a written attestation from the customer that it is validly licensed or a copy of the license. Collection of additional information also should be considered based on risk. Such information includes crop inspection or testing reports, license renewals, updated attestations from the business, and correspondence with licensing authorities.

The guidance also includes examples of suspicious activity for hemp-related businesses and information about currency transaction reporting.

Agencies propose revisions to interagency flood insurance FAQ

On June 26, 2020, the FDIC, Fed, OCC, NCUA, and Farm Credit Administration proposed revisions to “Interagency Questions and Answers Regarding Flood Insurance,” which was most recently updated in 2011. The new questions and answers are related to 2015 changes to flood insurance regulations stemming from the Biggert-Waters Flood Insurance Reform Act of 2012 and the Homeowner Flood Insurance Affordability Act of 2014. Specific update areas include escrow for flood insurance premiums, the detached structure exemption, and force-placement procedures.

CFPB proposes rule on escrow exemptions for certain HPMLs

On July 2, 2020, the Consumer Financial Protection Bureau (CFPB) issued a notice of proposed rulemaking (NPRM) to provide a new exemption from the escrow requirement for higher-priced mortgage loans (HPMLs), which typically require an escrow account to be established.

The exemption would apply to HPMLs secured by a first lien on principal dwelling for institutions with $10 billion or less in assets that originated 1,000 or fewer loans secured by a first lien on a principal dwelling in the previous year. Certain other criteria also must be met to qualify for the exemption.

Comments are due within 60 days of publication in the Federal Register.  

CFPB proposes two changes to requirements for mortgage loans

On June 22, 2020, the CFPB issued two related NPRMs concerning ability-to-repay and qualified mortgage (QM) requirements for residential mortgage loans under Regulation Z.

The first NPRM would amend Regulation Z to remove the existing 43% debt-to-income ratio as a general QM standard and replace it with a price-based approach. The second NPRM deals with the Government-Sponsored Enterprises Patch (GSE Patch) for Fannie Mae and Freddie Mac loans, which is set to expire in January 2021. The GSE Patch designates a loan as a QM if it is eligible for purchase or guarantee by one of the GSEs, regardless of other factors. The NPRM proposes to extend the expiration date of the GSE Patch until the effective date of the first NPRM, but it ultimately would remove the GSE Patch.

Comments on the first proposed rule, to define a QM with a price-based threshold, are due Sept. 8, 2020. Comments on the second, to extend the GSE Patch, are due Aug. 10, 2020.

CFPB launches advisory opinion program

On June 18, 2020, the CFPB announced a pilot advisory opinion program designed to provide clearer guidance within the regulations under the CFPB’s purview. The program will allow regulated entities to submit requests for clarification where uncertainty exists within a regulation, and the CFPB will select certain topics from these requests and make responses available to the public. Previously, responses to these types of inquiries typically were provided only to the requesting entity. These advisory opinions will be published on the CFPB’s website and in the Federal Register and will serve as official guidance for the particular area of the regulation. Requests for advisory opinions may be submitted via email.

While the pilot program is currently available, comments on the full advisory opinion program must be provided by Aug. 21, 2020.

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Paycheck Protection Program (PPP)

President signs PPP extension

Funding for the PPP ended on June 30, 2020, in accordance with the CARES Act; however, late on June 30, the Senate passed S. 4116, by voice vote, to amend the CARES Act to extend the program through Aug. 8. On July 1, the House passed the bill by unanimous consent, and on July 4, 2020, President Donald Trump signed the bill into law, officially extending the program.

Treasury and Small Business Administration issue interim final rule

On June 22, 2020, the U.S. Department of the Treasury and the Small Business Administration (SBA) issued an interim final rule (IFR), “Business Loan Program Temporary Changes; Paycheck Protection Program – Revisions to Loan Forgiveness and Loan Review Procedures Interim Final Rules,” amending the CARES Act. This IFR revises IFRs posted on the SBA’s and Treasury’s websites on May 22, 2020, and published on June 1, 2020, in the Federal Register, by changing key provisions to conform to the Paycheck Protection Program Flexibility Act of 2020, which was signed into law on June 5, 2020. Comments are due July 27, 2020.

A few points covered include:

  • Payroll costs are reduced from 75% to 60%.
  • Covered period is extended from eight to 24 weeks.
  • Maturity is extended to five years for loans made June 5, 2020, or after; extensions of the maturity date of earlier PPP loans are permitted by mutual agreement.
  • Application is completed by the borrower; the lender has 60 days to render a decision to the SBA.
  • The SBA has 90 days to remit the appropriate forgiveness amount to the lender, plus any interest accrued through the date of payment, after the lender issues its decision to the SBA.

AICPA releases accounting guidance for PPP lenders

The American Institute of CPAs (AICPA) and its Depository Institutions Expert Panel (DIEP) released, on June 30, 2020, three new Technical Questions and Answers (TQAs) to help lenders account for the PPP loans.

The new TQAs are included in Q&A Section 2130, “Receivables,” and address how creditors should account for the advance under the PPP, the SBA guarantee, and related fees as follows:

  • Section 2130.42 – classification of advances under the PPP
  • Section 2130.43 – consideration of the SBA guarantee under the PPP
  • Section 2130.44 – accounting for the loan origination fee received from the SBA

Crowe issues accounting guidance for PPP lenders

On July 9, 2020, to build on the AICPA’s TQAs, Crowe issued “PPP Financial Reporting for Lenders: 10 Questions Answered,” to address the following:

  • PPP loans and the allowance – classification, SBA guarantee, fair value option
  • Processing fees and associated considerations – claw-back provisions, deferred fees and costs, and amortization period
  • Forgiveness – classification during the settlement period

Main Street Lending Program

Fed launches two more facilities and continues to update FAQs

On July 17, 2020, the Fed announced two new loan options for nonprofit  organizations. The Nonprofit Organization New Loan Facility (NONLF) and the Nonprofit Organization Expanded Loan Facility (NOELF) are designed to provide credit access to nonprofit organizations such as educational institutions, hospitals, and social service organizations.

The Fed updated the Main Street Lending Program frequently asked questions document on July 15, 2020, to provide additional guidance on the expanded coverage of the program as well as other topics. The Fed has added questions and answers addressing covenants and certifications, regulatory treatment, and operational details.

Loan modifications

Supplemental call instructions provide reminder to maintain appropriate allowance

Financial institutions should maintain an appropriate allowance for loan and lease losses and should consider the effects of COVID-19 on the allowance. The FFIEC’s supplemental call reporting instructions highlight the following: “Institutions should continue to follow reporting instructions and U.S. GAAP for section 4013 loans, including:

  • “Appropriately reporting past due and nonaccrual status;
  • “Maintaining an appropriate allowance for loan and lease losses in accordance with ASC [Accounting Standards Codification] Subtopic 450-20 or ASC Subtopic 310-10, or an appropriate allowance for credit losses in accordance with ASC Subtopic 326-20, as applicable .”

AICPA releases accounting guidance for interest income recognition

The AICPA and its DIEP released, on June 30, 2020, a Technical Question and Answer to address how creditors should recognize interest income on a restructured loan resulting in periods with reduced payments. Specifically, TQA Section 2130.41 – determination of the effective interest rate – provides further clarification to the FASB staff announcement at the April 8, 2020, board meeting. 

CFPB issues interim final rule on loss mitigation for homeowners related to COVID-19

On June 23, 2020, the CFPB issued an interim final rule to provide clarification about loss mitigation options offered due to the COVID-19 pandemic. First, the rule clarifies that COVID-19-related loss mitigation options where limited application information was collected does not violate Regulation X, which normally requires servicers to collect a complete loss mitigation application. The loss mitigation option must meet certain criteria to qualify for this exemption, including deferred principal and interest payments. Any preexisting delinquency would be ended, and no fees may be assessed.

The rule also provides relief for servicers from certain Regulation X requirements related to loss mitigation applications, including the requirement to use reasonable due diligence to obtain a completed application and the requirement to provide an acknowledgment notice when an application is received. Other loss mitigation requirements under Regulation X remain in place.

Securities and Exchange Commission (SEC) need to know

Recent developments

Chief accountant speaks about importance of high-quality financial reporting

On June 23, 2020, SEC Chief Accountant Sagar Teotia issued a public statement, “Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19.” The statement reminds stakeholders of the audit committee’s vital role in high-quality financial reporting and, among other observations, highlights various accounting, auditing, and financial reporting issues raised by COVID-19. The statement also outlines the Office of the Chief Accountant’s ongoing engagement with the Financial Accounting Standards Board, the Public Company Accounting Oversight Board, international standard-setters, and other regulators in this dynamic reporting environment.

SEC staff provides additional COVID-19 disclosure guidance

The SEC Division of Corporation Finance (Corp Fin) staff continues to monitor how companies are disclosing the effects and risks of COVID-19 on their businesses, financial condition, and results of operations. On June 23, 2020, Corp Fin staff issued Disclosure Guidance Topic 9A, which is intended to supplement Disclosure Guidance Topic 9, issued March 25. Topic 9A provides the staff’s views on three aspects of COVID-related disclosures:

  • Operations, liquidity, and capital resources with respect to business and market disruptions. Companies are encouraged to evaluate whether disclosure of business or market disruptions included in earnings releases should, in light of potential materiality, also be included in management discussion and analysis.
  • Government assistance (for example, the Coronavirus Aid, Relief, and Economic Security Act). Companies receiving federal assistance should consider the short- and long-term impact on their financial condition, results of operations, liquidity, and capital resources as well as the related disclosures and critical accounting estimates and assumptions.
  • Going concern. Where there is substantial doubt about a company’s ability to continue as a going concern or the substantial doubt is alleviated by management’s plans, management should provide appropriate disclosure in the financial statements and consider how to address such matters in management’s discussion and analysis.

As noted in Topic 9A, disclosures should “enable an investor to understand how management and the Board of Directors are analyzing the current and expected impact of COVID-19 on the company’s operations and financial condition, including liquidity and capital resources.”

SEC hosts virtual roundtable on Q2 disclosure considerations related to COVID-19

On June 30, 2020, a panel of various financial statement users participated in a virtual roundtable with SEC Chair Jay Clayton and Corp Fin Division Director William Hinman to discuss their perspectives on what issuers should consider for quarterly COVID-19 disclosures as well as other topics including the importance of forward-looking information and human capital initiatives. Panelists included:

  • Gary Cohn, former director of the National Economic Council
  • Glenn Hutchins, chairman of North IslandTracy Maitland, president and CIO of Advent Capital
  • Barbara Novick, vice chairman and co-founder of BlackRock

An archive of the roundtable is available.

SEC updates regulatory flexibility agenda

The most recent SEC regulatory flexibility agenda update is now available. Potential rules of particular interest in the final rule phase include Update of Statistical Disclosures for Bank and Savings and Loan Registrants and Modernization and Simplification of Disclosures Regarding MD&A, Selected Financial Data and Supplementary Financial Information. In addition, the agenda has a proposed future rule on Earnings Releases/Quarterly Reports.

Want more insights on addressing coronavirus-related challenges?
Go to the Crowe COVID-19 resource center for more analysis and updates.

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Joe Durham
Joe Durham
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Sydney Garmong
Office Managing Partner, Washington, D.C.
Mark Shannon
Mark Shannon